Bank of Nova Scotia Is Selling TMX Group Limited: Should You?

Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) announced October 2 that it was selling 2.75 million shares of TMX Group Limited (TSX:X) for $67 per share, leaving it with less than 5% of the TSX’s common stock. In 2012, a consortium of banks and financial institutions including Bank of Nova Scotia acquired TMX Group for $50 per share to keep the exchange in Canadian hands. While the annual return on the shares sold is a paltry 6%, Bank of Nova Scotia does get $184 million to partially pay for its recent $800 million, 20-year sponsorship deal with Maple Leaf Sports & Entertainment…

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Bank of Nova Scotia(TSX:BNS)(NYSE:BNS) announced October 2 that it was selling 2.75 million shares of TMX Group Limited(TSX:X) for $67 per share, leaving it with less than 5% of the TSX’s common stock.

In 2012, a consortium of banks and financial institutions including Bank of Nova Scotia acquired TMX Group for $50 per share to keep the exchange in Canadian hands. While the annual return on the shares sold is a paltry 6%, Bank of Nova Scotia does get $184 million to partially pay for its recent $800 million, 20-year sponsorship deal with Maple Leaf Sports & Entertainment to put its name on Toronto’s hockey and basketball arena formerly nicknamed “The Hangar.”

At the time of Bank of Nova Scotia’s announcement in early September, I suggested that a good bank was making an abysmal capital-allocation decision that would cost Canadian shareholders in multiple ways.

Now, as it unwinds its position in TMX Group, a decision that makes sense given that the TSX appears to be on solid footing, I wonder if TMX Group shareholders should read anything into the sale other than it’s time to move on?

On board since 2012

If you’d bought shares of TMX Group shortly after Maple Group Acquisition Corporation completed its purchase of the TSX in September 2012, your 6% annualized gain has underperformed the TSX Composite in four of the last five years; that’s hardly a ringing endorsement.

As you consider what lies ahead, if you were told today that your X shares would return 6% annually over the next five years, given many experts believe equity returns will be lower in the next decade than they were in the previous one, I would guess you’d be thrilled.

A little over a year ago, I’d advised Foolish investors to avoid TMX Group and its $60 stock, suggesting they buy three $20 stocks instead: Transcontinental Inc.(TSX:TCL.A), Intertape Polymer Group(TSX:ITP), and Corby Spirit and Wine Ltd.(TSX:CSW.A). Despite two of the three stocks being in negative territory over the last year, Transcontinental’s excellent performance has the trio of stocks besting TMX Group by 300 basis points.

So, I have two questions as I ponder an investment in TMX Group:

First, can it return 6% annually between now and 2022? Second, aren’t there better alternatives? After answering both of these, I think we’ll have our answer whether you should sell or not.

Can TMX Group achieve a 6% return?

There’s no question it’s capable of delivering 6% annually over the next five years. In fact, X has been a very active stock over the past five years, producing annual returns of more than 25% on two occasions and a negative return of more than 20% on one occasion. If you remove the highest (104% in 2016) and lowest (-26% in 2015) annual return between 2012 and 2016, you get an average annual return of 5% — 100 basis points lower than its actual return.

As I stated last year, TMX Group is anything but a growth stock. In the second quarter ended June 30, its revenue decreased by 2% to $190.3 million, while its operating income increased 7% to $91.6 million. A closer look at its five different business segments gives little hope that it’s about to break out of its sales slump, despite a two-and-a-half-year process of altering its corporate culture to make it more adaptive to change.

Mediocre is probably the best way of describing TMX Group; it’s neither outstanding or awful in its overall performance.

So, yes, it’s possible TMX Group could achieve a 6% annual return over the next five years, but there are so many better alternatives.

Here are three in the financials sector

A quick search of the financials sector gives me 45 options with market caps of $500 million or more; TMX Group is the 19th largest.

Without going into too many details, I’d go with any of Fairfax Financial Holdings Ltd.(TSX:FFH), Onex Corporation(TSX:ONEX), or Power Corporation of Canada(TSX:POW).

Why?

All three are run by brilliant people: Prem Watsa at Fairfax, Gerry Schwartz at Onex, and Paul and Andre Desmarais at Power. They’re capital allocators to the core; none of these three are going to waste shareholder capital.

So, yes, I do think you should follow the bank’s lead and sell your shares. There are better fish to be fried elsewhere.

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Fool contributor Will Ashworth has no position in any stocks mentioned. Fairfax is a recommendation of Stock Advisor Canada.

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